Refinancing your mortgage is a growing trend. Recently we hear many of our friends, colleagues and other acquaintances bragging that they saved a fortune by home refinancing, by lowering their loan’s term or by doing other financial decisions and changes related with their mortgages

Upon considering refinance, we must remember that not all loans are the same and not all loaners get the same terms.  Sometimes, “forcing refinance”  will make a nice conversation topic but will end up with us losing money rather than saving it.

This article will look at some cases in which refinancing simple should not be applied, arguing that eventually home refinancing can be a good thing but not necessarily for every loaner.

First Bad Decision: reducing monthly payments and losing money overall

Let’s say you have a 200,000$ taken for 15 years in a 5.35% fixed rate. So today you are paying 1,618$ each month.
If after two years you decided to refinance your loan (182,441$ principal left) for anoter 15 years now with a 5.15% interest you may think you will now pay 1,457$ each month, correct? So a total saved costs of about 10,000$, nice?
Wrong! In this example we may tell our friends that we saved money – but actually we forgot that in the first 2 years we already paid around 20,000$ in interest alone, so basically we ended up paying 10,000 $ more, having the loan for a total of 17 years instead of 15 and also we will have closing costs which I overlooked.

Now, you may argue that there are sweet 150$ x 15 years x 12 monthes that we can save and gain interest on…
well, I doubt that this will be the case. Most lenders tend to spend the extra cash they gain, and even if they do – gaining interest by saving, simply does not add up to the accumulated loss.

Second Bad Decision: Preferring Cashing-Out Refinance rather than Home Equity loans?

In our articles about Cash-Out refinancing we argued that cashing out from our equity is an overall bad decision when it is not done for home-improvement purposes. But, sometimes you simply need cash and the euity is the only way to do so.
Here we argue that taking home-equity loans may be a better choice than refinancing your over-all principal, let’s see why:

Let’s say you have a 200,000$ loan that you paid for 2 years with a 5.05% interest rate. so now, you need another 25,000$ to pay for the construction of a new unit, a good financial decision since you are planning to rent it out to increase income.
So the options are:

-       Taking a home-equity loan for new 25,000$ for 15 years with 6.45% interest rate or

-       Refinancing the entire loan + cashing out on the balance, with 5.45% interest for another 15 years.

So, the second option is better right? You will pay 1% less on the 25K, yes? NO!
you need to refinance 182,000 $ which will have its cost, plus you will pay 0.4% more on this prinicipal!
so in option II you pay about 18,000 $ more on the original loan, instead of paying a difference of 1% (around 2,500$) between the interests in option I.

This decision looks innocent, by basically it happens a lot – people jump to the best available rate witout calculating the alternatives. Such a calculation can be easily done with the free mortgage calculators available everywhere.

Third Bad Decision: Refinancing to complicated loans we do not understand

KEEP IT SIMPLE. Does refinancing to a different hybrid mortgage with fixed switching option after 2 years of ARM makes sense to you? If not, you may earn money by choosing it and you may be losing just the same. The only certainty as that you will accommodate your lender’s profitability targets.

Try to look for simple and coherent mortgages and loans’ conditions. Most brokers will make more money from mortgages you cannot intuitively know if it saves you money. So don’t believe every lender, and don’t get tempted by reducing payment for a few years in order to get a different and complicated home loan later on.

Fourth Bad Decision: Refinancing without knowing your “Breaking Point”

We already saw in other articles throughout this webpage that some mortgages still have a prepayment penalty. Plus, the refinance process will have its closing costs.
Know your ”break-even point” – meaning, understand when will you actually cover the refinancing costs by the saving each month on the new mortgage payment. Don’t refinance if your breaking point exceeds the time you plan to stay in your property. Try keeping the breaking point to a short period of time, so that you can actually start saving from the refinance process.

In conclusion,

We have seen four bad decisions that make refinancing your mortgage a bad choice. There are many more cases where loaners get tempted but don’t actually save money from the refinancing, thus making it an unnecessary thing to do.
The temptation to benefit from the low interest rates we see today in the markets along with the temptation to be the designated “financial wiz” amongst your friends – makes us take irrational refinancing decisions. Think and act wisely, consult with experts and don’t get caught in a situation where refinance will not undoubtfully save you money.